The Ricardian equivalence hypothesis: evidence from Bangladesh

Abstract

This paper examines the Ricardian equivalence hypothesis (REH) and its sources of failure in the case of Bangladesh using various theoretical specifications, annual data from 1974-2001 and linear and non-linear time series techniques. The general findings tend to invalidate the REH: a finite time horizon and the presence of liquidity-constrained individuals are the sources of deviation from the REH. Empirical results reveal that real per capita private consumption (C) under various specifications is cointegrated generally at the 5% level with real per capita income (Y), government expenditure before and after interest rate repayments (G & G2), taxes (T) and the interest rate (r). Results reveal that an increase in G, G2, T and r reduces C and that an increase in budget deficits raises trade deficits. These results highlight the importance of fiscal policies in boosting private consumption and controlling trade deficits, which are the prime goals of stabilisation policies being followed by Bangladesh.